Last Updated Jun 6, 2011 9:40 AM EDT
Security Service Rates
This CD rate for the 7-year CD can vary by zip code, but generally ranges from 3.35 percent APY for a $500 deposit to 3.50 percent for $100,000 or more. By comparison, a 7-year Treasury Bond was yielding only 2.28 percent, while my favorite core bond fund, the Vanguard Total Bond Fund (BND), was only yielding 2.68 percent.
Of course, I was suspicious at first that it was another bait and switch tactic such as the American First Assurance CD advertisements I've seen to sell annuities. This one, however, checked out. Security Service is a six billion dollar credit union based in San Antonio, Texas. Bankrate.com gives them a three star (performing) Safe and Sound rating. More importantly, it's insured by the NCUA, an agency of the US Government, for $250,000 per depositor. There are ways of getting millions of dollars in insurance by titling the accounts to maximize insurance as NCUA and FDIC rules are virtually identical.
Just as important as the rate, this CD has a reasonable early withdrawal penalty of one year's interest, though it can be even lower if the CD is less than a year old. This is a particularly important feature if certain economists, like Wells Fargo's John Silvia, are right and we get into a rising rate environment.
Though I don't know with certainty that rising rates are coming, it could have a devastating effect on bonds. The potential bubble might cause intermediate term bonds like the Vanguard Total Bond Fund, or the 7-year Treasury, to fall by about five percent for each one percent increase in rates. For example, a rapid three percent increase could cause these bonds to lose 15 percent of their value.
With this 7-year CD, however, I would just pay the 3.50% early withdrawal penalty and invest it in a CD paying that three percent greater rate. If this happened, I'd avoid the 15 percent loss and earn the penalty back via that higher rate in a bit more than a year. And if rates stay low, I would still earn far more than the two bond alternatives.
So what I have bought is a US Government bond yielding 3.50 percent, with a "put" giving me the right to sell it back to them for 96.5 percent of par, plus I get to keep the accrued interest.
There are some caveats as you'll see on the next page.